INVESTMENT THESIS
LM Ericsson Telephone Co. (NGS: ERIC). Network revenue rose 6% in 3Q20, offsetting declines in digital services and managed services.
RECENT DEVELOPMENTS
The ERIC ADRs declined 21% in 2015, versus a decline of 6% for peers, and dipped 1% in 2014, lagging the 1% average gain for peers.
Non-GAAP EPS was an estimated 1.88 SEK for 3Q20.
CEO Borje Ekholm noted that multiple months into the pandemic, four-fifths of Ericsson continue to work from home while the company continues to execute on its focused strategy. The CEO stated that Ericsson continues to ‘win footprint in several markets leveraging our competitive 5G portfolio.’ Gross margin improved in all segments and for the total company reached 43.2%, up over 500 basis points year-over-year and the highest gross margin level since 2006.
The company continues to monitor the COVID-19 pandemic, which has not yet had a material impact on business. Year-to-date results, according to the CEO, strengthen Ericsson’s confidence in delivering on 2020 group targets.
For 3Q20, Networks revenue of 41.7 billion SEK rose 6% in IFRS and 13% organically. Networks operating profit of 9.17 billion SEK jumped sequentially from 5.26 billion SEK in 2Q20 and was up 27% year-over-year.
In terms of 5G networks in operation or pending as of 10/21/20, Ericsson has 112 commercial contracts and 65 live 5G networks operating in more than 25 countries. That was notable improvement from just three months earlier, when Ericsson customers had 99 commercial contracts and 54 live 5G networks in operation.
Network sales also continued to grow in Europe, reflecting market share gains that are at least partly reflective of lost share by Huawei.
Carriers worldwide have been responding to higher voice and data traffic with higher spending on their networks.
Investors were thus relieved that Ericsson reiterated confidence in achieving its planning assumptions for 2020, while also nudging up overall industry expectations. With 5G driving growth, the global RAN market in 2020 is forecast to grow 8%, revised upward from a prior 4% projection. Momentum remains strong in the huge North American market, which is forecast to grow 4% even with the T-Mobile-Sprint tie-up.
Ericsson reiterated key elements of its planning assumptions, including normal sales seasonality for an approximately 17% sequential sales gain from 3Q to 4Q20. Digital services may see a delay in reaching its operating margin target; additionally, software sales in Networks appears to be offsetting earlier expectations.
These challenges are not sufficient to offset the company’s positive outlook, in which overall network sales are exceeding expectations while contributing to overall gross margin improvement. Additionally, IPR licensing revenue is on track for 10.1 billion.
Ericsson competes in a fierce market environment, and must fend off low-cost Asian rivals outside the U.S. at the same time, we believe Ericsson has the technology, global reach, and deep carrier relationships in 3G and 4G that position it for success in the 5G market.
We look for 5G spending to accelerate in 2020 and particularly in 2021 within a multiyear ramp. We also believe that cost-cutting initiatives under prior management and execution by the current management team position Ericsson for profitability in a growing top-line environment. We are reiterating our BUY rating on the ERIC ADSs to a 12-month target price of $16 (raised from $14).
EARNINGS & GROWTH ANALYSIS
Ericsson posted an IFRS profit of 1.61 SEK per share, versus 0.74 SEK per share in sequentially adjacent 2Q20 and an IFRS loss of 1.94 SEK in the year-earlier quarter. Non-GAAP EPS was an estimated 1.88 SEK for 3Q20.
On a U.S. dollar basis, revenue of about $6.58 billion was up 11% year-over-year, aided by pronounced dollar weakness in the third quarter. The dollar/krona relationship has gyrated wildly as a result of COVID-19; the dollar was 10.04 at the end of 1Q20, 9.05 at the end of 2Q20, and 8.73 at the end of 3Q20. On a dollar basis, revenue exceeded the $6.44 billion consensus forecast. Also on a dollar basis, Ericsson posted a non-IFRS profit for 3Q20 of $0.21 per diluted ADR, versus $0.10 per diluted ADR in 2Q10 and a year-earlier loss of $0.20 per ADR. Ericsson topped the 3Q20 dollar-based consensus, which called for a profit of $0.16 per ADR, by a nickel.
VALUATION
On October 22 at midday, BUY-rated ERIC traded at $12.42, down $0.20.
Source: Argus
